Now it's time to put all of this knowledge to work and create a portfolio that is going to generate increasing amounts of annual income and create real wealth over the years.

The three important criteria in picking dividend stocks that, in 10 years, will generate 11% yields and 12% average annual total returns are:

• Yield
• Dividend growth
• Payout ratio

Yield

As we discussed, you don't want to chase yield. Never buy a stock simply because its yield is attractive. That being said, yield is a critical component of investing in dividend stocks. Starting out with a high enough yield will be vital to reaching your goals.

Just as, on one end of the spectrum, you wouldn't buy a stock with a 10% yield that was not growing or was unsustainable, you also wouldn't buy a low-yielding stock just because it was growing the dividend rapidly and the dividend appeared safe.

A low yielder might be attractive if it's a stock you're interested in for capital growth (you think the stock price is going significantly higher), but you wouldn't buy it for income.

Obviously, any stock you buy, even if it's for income purposes, you'll buy because you think that, over the long haul, its price will rise. If you think a company is a dog in an obsolete industry, you probably don't want to own it regardless of its historical dividend increases. If you believe the company is in trouble, you won't be able to sleep at night. And letting you sleep at night is exactly what the kind of stocks I'm talking about in this book are designed to do.

A company with a 1.4% dividend yield that has a low payout ratio and is raising its dividend by 10% per year is not going to get you where you want to be.

Even with a 10% dividend boost every year, your yield will only be 3.3% in 10 years.

That's not a terrible yield to start out with today, but we want much more than that 10 years from now.

Dividend Growth

The stock market is all about growth. Investors buy stocks whose earnings and cash flow are growing. Income investors want rising dividends. CEOs try to grow their sales and margins. Investors pay higher prices for companies that are growing. If a company stops growing, its stock price usually gets hammered.

A key component in the formula is dividend growth. Without it, the dividend will lose its buying power because of inflation. Even with low inflation, over the years, the money won't buy as much as it used to.

A company that raises its dividend by a meaningful amount every year typically has rising earnings and cash flow. It's a sign of a healthy business and, just as important, shows that management understands its fiduciary duty to shareholders.

The historical average dividend growth of the S&P 500 is 5.5% per year. That's not bad, considering the average inflation rate of 3.4%. Using historical averages, that means investors are getting 2.1% more buying power each year. So investing in the S&P 500 has kept investors ahead of inflation and preserves their buying power.

But we want to be way ahead of inflation. Inflation isn't always going to stay low. In some areas of the economy, it's already pretty darn high. Gas, food, and college tuition are just a few segments where prices seem to rise significantly every year, no matter what government statistics say.

Therefore, we want strong (but sustainable) growth in our dividend every year.

Payout Ratio

It's all about safety. Before you dive in and pick great stocks that will generate huge amounts of money, you want to ensure that the stocks will stay great and help you meet your financial goals. If the company's finances are not in good shape, it's likely to disappoint you sometime down the road. So be sure the company can continue with its dividend policy.

Warren Buffett's first rule of investing is “Don't lose money.” His second rule is “Don't forget rule number 1.”

Dividend investors should heed Buffett's words. For the compounding machine to gain momentum every year, the dividend needs to grow. If the company can't maintain dividend growth and has to slash the dividend, that derails the train (and likely the stock price). You'll most likely have to sell your stock at a lower price and start over with a new one.

By looking at a company's payout ratio, you can usually avoid most of the problem stocks that could lead a portfolio off the rails.

Remember, generally speaking I want to see payout ratios (based on cash flow) of 75% or less, unless the stock is a BDC, REIT, or MLP. In those cases they can be as high as 100% of cash flow since many of them have policies to pay out all or nearly all of their cash flow, although in those cases the margin of safety is much lower. It might only take a difficult year or two to disrupt an annual dividend growth streak.

Formula

To achieve 11% yields and 12% average annual returns in 10 years, we'll need to make some assumptions. We'll also change those assumptions so that you can see what you'll need to alter to obtain the 10–11–12 results you're looking for.

As I stated earlier in the book, I don't believe in dogma. Anyone who tells you that you should never, or always, buy a stock above or below a certain valuation, yield, payout ratio, technical indicator, et cetera, is lying either to you or to themself.

That's a pretty strong statement, considering how many people out there profess to have all of the answers to the investment world. But the markets just don't work that way.

Stocks have a tendency to stay overbought or oversold, to move farther in a direction than most investors are prepared for. The market is a living, breathing animal that has a mind of its own and doesn't concern itself with gurus' hard-and-fast rules.

That said, we can still use guidelines to shape our strategy and use historical figures and averages as points of reference. Very often stocks do revert to the mean, so if you buy stocks trading below their historical average price–earnings (P/E) ratios, chances are, somewhere down the road, the stocks will trade at that historical average once again.

Keep all of this in mind as I give you guidelines for the stocks that will create a great portfolio of income-producing assets designed to provide you with a yield of 11% and generate an average annual total return of 12% within 10 years.

If you discover a stock that you like but it is two-tenths of a percentage point below my suggested minimum yield, remember, the rules are not set in stone. If the payout ratio is 3% too high but you have good reason to believe earnings and cash flow growth will be strong over the next few years, go for it. These numbers are meant to be a guide. They're good ones, but they're only a guide.

Before I give you those guidelines, here are those assumptions.

Assumption 1. Unless otherwise stated, over the next 10 years, the stock will appreciate 7.84% per year, equal to the historical average of the stock market since 1961.

That 7.84% return includes the Great Recession, various market crashes, and run-of-the-mill bear markets. It also includes good times, like the bull market of the 1990s and the 2010s.

I know there are lots of bears out there who believe this time it's different. That our country and the world has dug itself a hole so deep, it will never be able to get out of it.

In the first edition of this book, which was written in late 2011, the previous paragraph concluded this way: “Maniacal world leaders now have nuclear weapons, housing isn't likely to bounce back soon, we're running out of oil, and every other scary thing out there is going to cause the stock market to fall.”

Interesting that only three years later two of those problems are gone. Unfortunately, there are still maniacs with terrible weapons. But housing has bounced back and the United States is now flush with oil and other cheap energy.

Of course, there are other problems we can still point to: terrorists running rampant in the Middle East, crushing debt, economies around the world still limping along, global warming and the rising oceans. …

There are still lots of scary things out there that could cause the market to go down, including the fact that as I write this we're more than five and a half years into a bull market.

So maybe the market will fall. I don't forecast the market. What I do know is that we've had some pretty bad times before. While Hitler's army caused unspeakable carnage in Europe and 60 million people—2.5% of the world's population—died during World War II, the stock market performed extremely well.

As I mentioned earlier, in 76 rolling 10-year periods, the market has been negative only 7 times. There has been a lot of calamity in those 86 years. Wars, assassinations, civil unrest, scandals, shortages, and horrible political leadership—and through it all the market was positive 91% of the time after 10 years, and significantly positive, at that. On average, investors more than doubled their money every 10 years in the market.

Yes, the world has some problems right now. Some are extremely serious. But I'm going to side with history and assume that the next 10, 20, and 30 years are going to be similar to the last 50—and that stocks will rise in line with their average of 7.84%.

And keep in mind that dividend stocks, particularly those with solid yields that are growing their dividends, historically have outperformed the market. So our 7.84% assumption may be conservative. I don't think it's unreasonable to expect a 9% or 10% average annual price increase from these types of stocks if the general market is hitting its average of 7.84%.

I'll run some scenarios where the market underperforms the average and even some where the market stays flat or loses money to show you how the formula performs in all types of markets.

Assumption 2. The averages are consistent. In the financial model that we've built to analyze these prospective portfolios, we have to assume that the average stock performance and dividend growth is consistent. That will certainly not be the case in real life.

Even if stocks go up an average of 7.84% per year over the next 10 years, your stock is obviously not going to do that every single year. It might rise 10% this year, rise 5% the next, fall 4% the following, be flat, climb 20%, and so on. Those price moves will have an impact on your total returns.

If you're reinvesting your dividends for the long haul, the best-case scenario is actually a weak stock market where your company is still growing earnings and dividends. That way you get to reinvest the dividends at lower prices. The only time you should care about the stock price climbing is if you want to sell. If not, let your stock stay in the dumps and be undervalued—as long as the dividend is growing and sustainable.

It feels very contrary to every emotion we've ever had about the market, but I actually get annoyed when one of my dividend stocks goes higher.

If one of my stocks popped over 10% after strong earnings and a dividend hike announcement, now instead of reinvesting my dividends at around $29 per share, I have to reinvest at $33. It's nice to have a $4 gain in the stock, but it doesn't really matter to me now since I'm not planning on selling it for 20 years. I'd rather have it be at $29 (or $25) so that I can buy more shares every time a dividend is issued.

We have to model the averages as a consistent number because we have no idea how the market will play out, even if it does perform according to averages.

You can play with the dividend calculator, which is available for free on the Get Rich with Dividends website at www.getrichwithdividends.com, and change the variables to see how the investment will perform when the inputs change. You can also access a dividend calculator at www.wealthyretirement, which is the site for my free e-letter, Wealthy Retirement, and is available at www.wealthyretirement.com.

If you're especially bearish or bullish, try to resist tinkering with the average return of the stock. Even the professionals—or, I should say, especially the professionals—get it wrong. How many times have you seen a previously bullish analyst downgrade a stock after the company missed earnings and the stock cratered? How many times have you seen a prominent Wall Street money manager be completely wrong on the direction he predicted stocks were going to move?

It happens all the time, so do yourself a favor and stick with the averages. If you want to change the average to see what happens in bullish or bearish scenarios, that's fine (and I'll do that for you in the pages that follow), but resist the urge to change the stock's price each year based on what you think is going to happen.

Ditto for the dividend growth figures.

So, here's the moment you've been waiting for: instructions on how to set up your own 10–11–12 portfolio.

As they say, “Safety first.” The first item we're going to look at is designed to keep your portfolio safe and to ensure that the stocks you buy will continue to be able to pay and grow their dividend.

Payout Ratio: 75% or Lower

Not including REITs, BDCs, and MLPs, I look for companies whose payout ratios are 75% or lower, with growing sales, earnings, and cash flow. Of any of the guidelines, this is probably the one you want to stick to the closest, because we're talking about the stability of the dividend. If you go outside the boundaries on yield or dividend growth and things don't work out right, you may make a little less money than you thought.

But if the dividend is cut, chances are your stock is going to fall, maybe significantly. And you probably won't want to be invested in it anymore and may sell for a loss.

In this entire strategy, the reliability of the dividend is the most important factor. If you're relying on dividends for income, you may not be able to afford a cut.

A reduction in dividends may set a wealth-building program back a bit, which wouldn't be as devastating as it may be to the investor who needs the dividends to meet living expenses, but it still would be a hindrance to achieving your goals.

Of course, if you find a stock with a payout ratio of 50%, you have plenty of margin for error. Even if business stinks and earnings fall, there should be plenty of cash to continue to pay the dividend.

Should that happen, keep a close eye on the payout ratio. Management may be reluctant to cut the dividend, especially if the company has a long track record of raises. But if earnings are on a downtrend and the payout ratio is increasing, management may be forced to lower the dividend paid to shareholders. If the payout ratio starts moving higher, it may be a hint that a cut or a halt to the raises is coming.

Ultimately, you'd like to be invested in a company with sales, earnings, and especially cash flow that are on the rise. With a reasonable payout ratio, that gives management plenty of room to continue to increase the dividend.

Don't get bent out of shape if the company has a bad year or two, particularly if the payout ratio is low enough that the dividend isn't threatened. But if a company has year after year of negative sales, earnings, or cash flow growth, you might want to start looking elsewhere. It's not going to be the healthiest company, even if the payout ratio is low and the dividend continues to grow.

In a perfect world, I'd like to see 10% or more growth in sales, earnings, and cash flow, but that is not always easy to find, particularly in mature, stable companies that have a long history of dividend growth. So be sure to keep an eye on the company and look for at least some growth in those areas.

By following the payout ratio and noticing that it's redlining (75%+), particularly if it has risen in a hurry, you should be able to bail out before things hit the fan.

Let's look at an example of a company that cut its dividend and see whether we could see any warning signs.

Table 8.1 and Figure 8.1 show the dividends paid out by Vulcan Materials Company (NYSE: VMC), which cut its quarterly dividend in half in the third quarter of 2009 to $0.25 from $0.49 per share. I've included the payout ratios based on net income, cash flow from operations, and free cash flow.

	2004	2005	2006	2007	2008	2009	2010
Dividends	$106	$118	$144	$181	$215	$171	$128
Net income	287	389	468	451	(4)	30	96
Payout ratio	37%	30%	31%	40%	NM	570%	133%
Cash flow/operations	$581	$473	$579	$708	$435	$453	$203
Payout ratio	18%	25%	25%	26%	50%	38%	63%
Free cash flow	$377	$258	$144	$225	$82	$343	$116
Payout ratio	28%	46%	100%	80%	262%	50%	110%

Could we have foreseen a cut coming?

You can see that the payout ratios, according to net income and cash flow from operations, were all in a very safe area until 2008, when, because of a net loss, the payout ratio based on earnings is not meaningful (and falls to zero on the chart). Based on cash flow from operations, it was still 50%, which is normally fairly stable. However, this sudden doubling of the payout ratio rather than a nice steady trend upward should have set off some alarm bells.

Free cash flow gave us a warning even earlier, when the payout ratio hit 100% of free cash flow in 2006. That should have put investors on alert. Dropping down to 80% in 2007 may have changed it to a code yellow from code red, but shareholders still ought to have been watching it carefully. Then in 2008, dividends exceeded free cash flow. At that point, investors should've thought very carefully about whether Vulcan was a stock that still belonged in their portfolios.

Of course, 2008 was when the financial crisis hit, and it was a bad year for everyone. But the sudden pops in the payout ratio served as a warning that the dividend was in jeopardy.

Notice that the dividend wasn't cut until the second half of 2009. When things get bad, management typically is reactive instead of proactive. It will try hard not to cut the dividend even if bad earnings numbers are expected. Companies often wait until the last possible minute to avoid further angering shareholders, who might already be steamed by the weak profits and performance of the stock.

Very often, the warning signs are there a few quarters before the cut occurs, giving vigilant investors time to make changes to their portfolios.

Vulcan's fourth-quarter 2011 dividend was cut to $0.01 from $0.25. That's no surprise, considering:

• Payout ratio on net income: not meaningful—the company has been profitable in only one of the last eight quarters.
• Payout ratio on cash flow from operations: 65%, up slightly from 2010s spike.
• Payout ratio on free cash flow: 135%, up 25 percentage points from 2010s already-high level.

Analysis on the payout ratio should have kept any dividend investor out of the stock regardless of its yield, which was 3.2% before the cut.

Occasionally, a company will state a payout ratio policy in a quarterly report, annual report, or earnings conference call. The payout ratio goal is usually based on earnings of free cash flow.

That's worth paying close attention to. If the company does not grow its earnings or free cash flow, dividend growth could be in trouble, or the payout ratio is climbing higher than management originally intended. Listen to or read the transcripts from the company's earnings conference calls to see if the CEO or CFO mentions the change in the payout ratio policy. That way you can assess whether management is doing the right thing for the business or whether you need to get out while the gettin's still good.

On the other hand, if earnings and free cash flow are growing and the company has a stated payout ratio policy, the dividend should grow along with it. If it doesn't, again, listen for any changes in the policy.

In its third quarter 2014 earnings call, the CEO of Covanta Holding Corporation (NYSE: CVA) said his company was targeting a 50% payout ratio based on free cash flow. He added that the goal is to grow free cash flow so that it can be reinvested into the business to grow it even more and maintain that 50% payout ratio, lifting the dividend along with it.

As a shareholder, that free cash flow figure would be something I'd keep an eye on—not too closely, however. Remember, we don't want to overtrade and react to every variation in every quarter. We're long-term investors so we're going to let some things work themselves out and smooth out over time. But if you see after a year that the payout ratio is too high, and after another year or two it hasn't dipped back to that 50% mark, then it might be time to look for another investment.

On the other hand, if free cash flow is growing strong and the payout ratio is below 50%, you might expect that a big dividend increase is coming.

If management mentions a payout ratio goal, pay attention to it and follow it over time.

Numbers

In the next tables, I'll lay out for you what starting yield you need to reach the 10–11–12 goals based on various dividend growth and price appreciation assumptions.

Table 8.4 and the tables to follow show the yield and the amount of dividend income if dividends are not reinvested. The next two rows are the yield on original cost and yearly dividends if dividends are reinvested. The last two rows are the compound annual growth rate and total value, so you can see that we're hitting our goal of 12%.

Below Table 8.4 and the rest of the tables is a list of the assumptions we're making. So in this one we have average market performance of 7.84%, 10% annual dividend growth, a $10,000 starting investment, and a 4.7% starting yield.

The assumptions are the basic formula. Assume that over the next 10 years, the market is going to appreciate the same amount as its historical average. Next, find a stock with a dividend growth rate of 10% (that is likely to continue at that rate) and a starting yield of 4.7%.

You can see that in 10 years, we've achieved the 11% yield when dividends are not reinvested and a 13% average annual return when dividends are reinvested. Also notice that when dividends are reinvested, the yield on your original investment is now nearly 18% rather than 11%.

In Table 8.5, we're modeling a slower market than usual. Even if you're somewhat bearish, this is a safe assumption as the market has been up 67 out of 74 times over the past three-quarters of a century. If we hit a bear market during some part of the next decade, chances are we'll still finish the 10-year period up. A 5% annual stock market return would be a pretty big disappointment for most investors.

Notice in this scenario that you need a higher starting yield to make up for the weak market. To reach our goals, you'll have to start out with a 5.3% yield and hit the 10% dividend growth numbers.

If you do, you'll have a 12.5% yield in 10 years, or 22% if the dividends are reinvested. That's because you're reinvesting the dividends at lower stock prices than in the first scenario, buying more shares with a higher dividend per share. As compounding works its magic, it will result in a greater return as the years go by.

After 10 years, your return in percentage and total dollars is a bit lower than in the first scenario, but after 20, all those cheap shares you bought add up and generate a 14% return.

In Table 8.6, we're planning for another decade like the one we had recently, the 10-year period known as the lost decade. From 2002 to 2011, the return of the S&P 500 was, to use a technical term, bubkes. It averaged less than 1% per year.

If you invested your money on December 31, 2001, and didn't look at it again until 10 years later, you had no idea what a wild ride it was. All you'd see is that your portfolio barely budged.

In the next 10 years, we're going to assume the market is slightly worse and doesn't return a penny. That $10,000 invested in the S&P 500 is worth $10,000 a decade later.

But look, even with a flat market, strong returns are possible. You'll have to find a stock yielding 7.2% to hit our numbers, but it can be done.

For what it's worth, if you invested in an easier-to-find stock yielding 4.7% that grew its dividend 10% per year in a flat market, you'll still get that 11% yield after 10 years, or nearly 22% if you reinvested the dividends. And your average annual return would be 7.7%, which would more than double your money.

I don't think anyone would complain about that. Would you have complained about a 7.7% annual return on your portfolio between 2002 and 2011? Probably not. If the market returned zero but you got 7.7%, you'd probably be thrilled at your good fortune.

In Table 8.7, I chose an average annual return of –1.2% because that was the average for the 10-year periods that were negative. It's certainly possible that we could experience an even worse decline, but considering how few times negative returns occurred, I believe the average is a safe assumption.

Look how high the numbers get, particularly beyond 10 years, when you reinvest the dividend. That's when the compounding machine really begins to gather momentum.

The fact that the stock price is declining allows the investor to buy more shares at a lower price. Those lower-priced shares still generate significant income, which is being put right back to work in more lower-priced shares. As a result, the investor accumulates a ton of shares, which, even with the lower stock price, becomes worth a significant amount of money.

Imagine if we hit a bear market so rough that, for 20 years, the average return of the market was negative (that has never happened, by the way), and you turned your $10,000 original investment into nearly $1 million. To say you'd be ecstatic would be an understatement.

Reality check: If we hit a sustained bear market that delivered annual negative returns over the course of 20 years, it might be difficult, even for the best Perpetual Dividend Raisers, to continue raising their dividends at 10% per year. But keep in mind that during the Great Recession years of 2008 and 2009, plenty of companies continued to raise their dividends at double-digit paces.

I have no doubt that during the next long and significant decline in the market, many companies will find a way to raise the dividend, even if it's just a few percentage points as a token amount to keep their records intact. In January 2012, Kimberly-Clark (NYSE: KMB) raised its dividend for the 40th consecutive year, which includes the Great Recession of 2008 and 2009.

Kimberly-Clark had been raising the dividend around 9% to 10% per year, including 9.4% in 2008. However, in 2009, it tapped on the brakes and raised the dividend by only 3.4%. In 2010, however, it was right back to a 10% raise.

As long as the dividend is growing, you'll still acquire lots more shares, which will increase the value of your holdings significantly, not to mention the income should you decide to stop reinvesting.

To illustrate the power of compounding, even in a bear market, look at how many shares you'd have at the end of 10 and 20 years based on the first example, where the starting yield is 4.7% and the dividend grows 10% per year. (See Table 8.8.)

I'm sure it jumps out at you how many more shares you have the worse the stock performs. It's astonishing to think that a sustained bear market would make you richer than a bull market.

In the first 5 to 10 years, that's not so. The bull market wins. But as the compounding magnifies, you're buying hundreds or even thousands of shares per quarter. And even at lower stock prices, all those shares add up to make you wealthy.

Another thing to consider: If we are unfortunate enough to experience a 20-year bear market or at least a market where the average annual return is negative over 20 years, chances are that inflation will be very low.

That would make your returns even more valuable. If you turned $10,000 into even a few hundred thousand dollars during that kind of economy, you probably would not lose much if anything to inflation. And I guarantee that if you turn $10,000 into several hundred thousand dollars during a 20-year bear market, you'd do better than 99% of the people out there.

From 1929 to 1941, prices declined by an average of 1% per year. And that includes the 5% inflation rate of 1941, when the war effort was kicking into gear.

So, if we experienced deflation, where prices are falling, your dividend windfall would actually be worth even more in real purchasing power.

Next, we look at a strong market. Interestingly, in Table 8.9 you'll notice the average annual return when you reinvest the dividends stays constant. That's because the growth rates of both variables are the same.

You also see that your $10,000 quadruples to $40,000 in this bull market when you reinvest the dividends. And after 20 years, your yearly dividends are equal to 70% of your original investment.

A 10% dividend growth rate is the goal, but we might not always be able to achieve it. Let's look at some of the similar scenarios with 5% dividend growth instead, so you have an idea as to what kind of returns you can expect at the lower growth rate.

The first thing that jumps out about the calculations in Table 8.10 is that the average annual return is actually declining—not the value of the investment. Your money is still growing. But the annual return is slowing. That's because the dividend growth rate is lower than the stock price appreciation. The increasing dividends that you're receiving are not keeping pace with the rising cost of the stock.

For example, in the fourth quarter of year 5, your reinvested dividend buys 12.1 shares at $14.58 (initial purchase price is $10). Five years later, in the last quarter of year 10, you'll buy 12.8 shares for $21.27. You're buying 6% more shares in year 10 but paying 46% more.

Think of it another way. The dividend growth rate is your increase in income, and the stock appreciation is the rate of inflation. You're getting a raise of 5% every year, but the cost of living (buying more shares) is increasing 7.84%, so your income, although it's going higher, is not keeping pace with the thing you want to buy (the stock). This isn't a bad thing as you're still compounding the dividends and increasing your wealth. There's nothing wrong with an 11.8% total return over 20 years, turning $10,000 into more than $93,000.

By comparing Tables 8.11, 8.12, 8.13, and 8.14 with the 5% dividend growth with those with the 10% growth, you can see that the difference in dividend growth rate certainly makes a difference, but not a huge one.

Again, even with slower dividend growth, $10,000 still grows by more than 11 times over 20 years when the market is negative.

For example, in the average market scenario with the 4.7% yield and 7.84% stock appreciation, after 10 years of reinvesting the dividend, the $10,000 original investment is worth $35,147 with 10% dividend growth and $31,998 with 5% dividend growth. The total returns were 13.39% and 12.33%, respectively.

As the years go by, the difference becomes more significant because of the effect of compounding. In a perfect world, you want a high starting yield and high dividend growth. Since that's not always achievable, try to come up with a combination of both, but be sure your original yield is high enough so that when compounding's magic does kick in, there's a meaningful base that's high enough to help you achieve your goals.

One other note on the 5% dividend growth scenario: You need a 7.1% starting yield to achieve an 11% yield in 10 years. To get a 12% total return in 10 years with dividends reinvested, you'll need to see the stock appreciate an average of 5% per year.

When to Sell

I'd love to give you a definite rule for when to sell your positions when the stock doesn't cooperate, but as I said earlier, I don't believe that you should always buy or sell according to exact criteria. There is one situation, however, in which I do think selling right away makes sense.

So as with the earlier scenarios, I will give you some guidelines.

Say the money has been compounding for a number of years, and you're getting close to that 10-year mark or have surpassed it. Perhaps an emergency comes up where you need cash. If at all possible, find it somewhere else. Even if you have to borrow money, it might be worth it to avoid interrupting the compounding machine.

For example, you can get a home equity loan for 5% or even a credit card loan for 10%. If your dividend stocks are yielding 11% and generating 12% average annual returns (which are going to increase as the years go by), it might be worth it to borrow the money instead of dipping into your dividend stocks. As long as those stocks have a higher yield (after taxes) than the cost to borrow funds, keeping the compounding going might be a good idea.

You've already put in the hard work and waited years for the reward; make sure you get it.

At least once a year, look at your stocks to see if any of the following has occurred:

• Increased payout ratio
• Decline in cash flow, earnings, or sales
• Change in dividend policy

The Vulcan Materials Company example earlier in the chapter showed how keeping an eye on the payout ratio might have tipped you off that there was going to be a problem with the dividend.

If the company's payout ratio suddenly spikes, investigate why.

Same with a decrease in the company's sales, cash flow, or earnings. You want to have a clear understanding of why the numbers are falling and, importantly, how it affects the payout ratio. If the payout ratio is low enough, the falloff in cash flow may not threaten the company's ability to raise the dividend. However, if the company's financial performance could put the dividend hike in jeopardy, you want to know that before it happens.

If you see the payout ratio climbing quickly, or sales, cash flow, or earnings dropping, it doesn't mean you have to sell the stock right away. But at that point, I'd start looking at the company's performance every quarter rather than just once a year to see whether the situation is addressed and corrected.

If you see the problems continuing, I wouldn't wait too long to sell. At that point, you can take your capital and find another dividend-paying stock with better metrics.

A change in dividend policy may be a bit more serious. If the company cuts the dividend, sell.

A company with a history of raising dividends that suddenly cuts the dividend has made a profound statement. Management is clearly not confident in the company's future and ability to grow the dividend. Furthermore, the whole reason you're in the stock—to generate ever-increasing income—no longer exists.

If a company keeps the dividend the same instead of raising it, that's not quite as cut-and-dried. Each situation is a bit different. Not raising the dividend after 40 straight years of hikes is a more significant event than no dividend hike from a company with a seven-year track record of increases.

If you've been compounding for a while and have a great yield, you don't necessarily have to sell right away. See whether the company can get things going in the right direction again. Some companies have a tendency to start and stop dividend boosts. They might raise the dividend for five years, then keep it flat for three, raise it again for four, and so on.

Take a look at the transcripts of the company's conference call, and see whether management addresses why the dividend wasn't raised. If not, call investor relations and see what they say. As an owner of the company, you have every right to ask what's going on.

If you're enjoying an 11% yield and the company doesn't lift the dividend, but the payout ratio is reasonable and the company is still seeing growth in sales, earnings, and cash flow, there may not be a reason to panic.

In other words, take a good look at what's going on and use your judgment. With tools you now have, you can assess whether a company is healthy enough to continue to provide you with the income and returns that you expect. If it still can generate those returns, even though it did not raise the dividend, and if your yield is satisfactory, keep the stock. If, however, you have concerns that the dividend is not stable and may be cut, you're better off selling and looking for other opportunities.

Summary

• You can achieve an 11% yield and a 10-year average total return of 12% in 10 years.
• To do it, you need a 4.7% starting yield and 10% dividend growth, assuming the market performs as it has historically.
• Try to invest in stocks with a minimum of a 4% yield, 10% annual dividend growth, and a maximum payout ratio of 75%.
• Calculate the payout ratio based on cash flow from operations or free cash flow.
• You can make gobs of money reinvesting dividends in a stock that declines.
• Because I'm such a nice guy, I'm providing a free calculator at www.getrichwithdividends.com and www.wealthyretirement.com to help you figure out the future yields and total returns of your stock based on the variables that you enter.